Two-Parent Families with Children: How Effective Tax Rates Affect Work Decisions
Working parents with childrenparticularly low-income families face prohibitive tax rates that discourage taking on extra employment to get ahead, according to a new report from the C.D. Howe Institute. In “Two-Parent Families with Children: How Effective Tax Rates Affect Work Decisions” author Alexandre Laurin finds that mothers and poorer families are the most adversely affected by this tax trap.
The report examines how the tax and benefit system impacts take-home pay by combining the effects of both taxes paid and loss of government benefits to produce marginal effective tax rates (METRs) that show the tax bite from each dollar of extra income. Because benefit programs are targeted at the lower end of the income scale, low- and middle-income families’ effective tax rates are generally higher than those of higher-income families.
Laurin finds that METRs generally peak at family incomes between $35,000 and $50,000. In Ontario, the family METR on extra earned income peaks at 64 percent. In Quebec, it peaks at 73 percent. In other provinces, it tends to peak just above 50 percent.
In 2017, about 9 percent of employed parents contemplating earning a few extra dollars, and about 13 percent of stay-at-home parents contemplating getting a job, faced an effective tax rate higher than 50 percent.
The report recommends:
• Subsidizing Child Care: In the current system, childcare expenses (CCE) must be deducted on the tax return of the lower-earning spouse, and claims cannot exceed the lowest of either (a) two-thirds of the spouse’s income or (b) a maximum claim per child. As a result, up to one-third of families cannot fully deduct their CCE because of the two-thirds of income limit (mostly among those at lower income levels) or the maximum claim limits (mostly among those at higher income levels). Laurin proposes a federal refundable credit for childcare costs with very generous rates for lower-earning families designed along the lines of the Quebec childcare expenses credit. “Parents, especially mothers, have been shown to be particularly sensitive to changes in childcare costs,” says Laurin. “A more generous tax treatment would likely encourage about 15 to 22 percent of stay-at-home mothers to join the workforce and stay employed over the long term.”
• Income Averaging: One way to lessen the impact of fluctuating income on tax liability is to allow workers to average their income over many years, so that any single large earning year would not lead to higher tax payments and a disproportionate loss of fiscal benefits.
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